Tag: banks

1919 Cover of The Natural Economic Order

Feasibility of Interest-Free Demurrage Currency

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Setup

Natural Money is an interest-free demurrage currency. It features a holding fee on currency and a maximum interest rate of zero on money and loans. The Natural Money currency is an accounting unit only, as the holding fee, which may range from 0.5% to 1% per month, makes the currency unattractive to hold. Therefore, the currency will not circulate, nor will someone invest in it. Cash, bank deposits, bonds, stocks, real estate, and other investments aren’t currency and therefore not subject to the holding fee. Not paying the holding fee and the curtailment of credit, and thereby inflation, caused by the maximum interest rate, can make lending at negative interest rates attractive.

Natural Money features a separation between regular banking, also known as commercial banking, which involves lending and borrowing, and investment banking, also referred to as participation banking, which involves participating in businesses. Regular banks guarantee returns to their depositors and use their capital to cover losses. Participating banks have shareholders who share in the profits and the losses. These two bank types should remain separated, even though one bank might offer both in distinct accounts. A commercial bank’s funds should be used only for lending. The maximum interest rate limits lending, allowing equity to replace debt in the financial system.

Evidence from history

There is little historical data on the subject of interest-free demurrage currency. Financial systems founded on interest-free money with a holding fee have never existed. There were holding fees and interest bans, but the combination of both has never existed. More importantly, a usury-free financial system requires a high-trust society founded on moral values where investments are safe, and is only feasible with the help of several relatively modern financial innovations. That all seems too good to be true, but we can have dreams. And so, the evidence from history is of limited value.

Several ancient societies have seen usury-induced economic crises. Extreme wealth inequality, often accelerated by usurious lending, regularly coincided with societal collapses. It is a recurring pattern that has existed since time immemorial. The Sumerians were already familiar with charging interest and its disastrous social consequences. Sumerian rulers began implementing debt jubilees as early as 2,400 BC, cancelling debts and freeing debt slaves. Other cultures, such as those in Israel, have banned charging interest. Israel also had debt jubilees every fifty years.

The Egyptian grain-backed currency existed for over 1,000 years, suggesting it provided monetary stability. Nevertheless, ancient Egypt has seen economic crises, often due to droughts causing crop failures, high taxation during warfare, or a weakening central government. The government mitigated famines with its grain reserves, but prolonged famines depleted these facilities, leading to civil unrest and, sometimes, a collapse of order. There is no evidence of social benefits of this money for Egyptian society. Charging interest was common, and Egypt had debt cancellations.

In the Middle Ages, the Church forbade charging interest. Christians, like Jews, were each other’s brothers and couldn’t charge each other interest. When economic life became more developed, the ban on interest became difficult to enforce. In the 14th century, partnerships emerged where creditors received a share of the profits from a business venture. As long as the share remained profit-dependent, it was not illegal, as it was a participation in a business rather than lending at interest.1 Islamic finance works with similar principles.2

In the 17th and 18th centuries, interest ceilings replaced bans. To circumvent the interest ceilings, a creditor and debtor could secretly agree on a fraud, whereby the creditor handed over less money than stated in the loan contract, so that the borrower actually paid more interest.3 More recent experiences with Regulation Q in the United States, which imposed maximum interest rates on bank accounts, suggest that a maximum interest rate is enforceable only if it does not significantly impact the bulk of borrowing and lending.4

An effective ban on usury requires a society grounded in moral values rather than profit. It requires us to live modestly and within the planet’s limits. It also requires societies to care for vulnerable individuals, so that they don’t fall prey to usurers. You shouldn’t charge interest, not merely because it is illegal, but because it contributes to something profoundly evil. That points to a broader problem. We should care about the world and consider the consequences of our actions. Even when what we do is legal, it doesn’t mean that it is good.

Implementation

To implement Natural Money, interest rates must already be low or negative. Attempting to lower interest rates when market conditions don’t justify that move would likely scare investors. Low interest rates require trust, which requires financial discipline, including fiscal discipline from governments. That doesn’t equal austerity, since governments earn interest on their debts when interest rates are negative. The transition preferably is a gradual process that the authorities communicate in advance. Whether that is possible at all remains to be seen, as the implementation may occur in exceptional times.

If there is still a functional currency, the first step is for the government to balance the budget. The second step is to decouple cash currency from the administrative or central bank currency. The move encompasses retiring central bank-issued banknotes and replacing them with treasury-issued banknotes. Not everyone will hurry to a local bank office to exchange banknotes, so the central bank-issued banknotes must be exchangeable at par for the new banknotes for a considerable period.

As long as interest rates are significantly above zero, a holding fee won’t bring them down. Setting a maximum interest rate can lower interest rates by curtailing credit, thereby cooling the economy. To avoid disrupting financial markets, the implementation must be gradual. The maximum interest rate should be high enough to avoid disrupting the economy. Initially, authorities could set the holding fee at a low percentage, or not at all. As interest rates fall, authorities can lower them.

The zero lower bound is a minimum interest rate. It operates like a price control by preventing interest rates from moving freely to the rate where supply and demand for money and capital balance. That is to the advantage of the wealthy, as they can take the economy hostage by demanding a minimum return on their investments. When returns are low, investors may prefer cash over investments, which can hinder an economic recovery. Economists call it liquidity preference.

Low interest rates can prompt lenders to seek higher yields and take on more risk. Low interest rates allow borrowers to take on more debt. Low interest rates can promote investments that become unprofitable when the economy slows down. A maximum interest rate can prevent these situations from happening. A maximum interest rate caps the risk lenders are willing to take and promotes a deleveraging of balance sheets, so that even low-yielding ventures don’t go bankrupt because of interest-bearing debts.

Issues with the maximum interest rate

A holding fee will cause few difficulties, but a maximum interest rate is more problematic. Insofar as the maximum interest rate affects questionable segments of credit, such as credit card debt and subprime lending, this is beneficial overall. More serious issues can emerge with financing small and medium-sized businesses. Partnership schemes can fill in the gap, but it is hard to predict how that will play out. The maximum yield on loans is zero, making partnerships more attractive, as they can offer higher returns.

There may be objections to the limits Natural Money imposes on consumer credit. Still, there is little doubt that a maximum interest rate can improve consumers’ purchasing power, as borrowers won’t have to pay interest. As a result, there are fewer borrowing options, which may lead to the emergence of black markets. To make illegal schemes unattractive for lenders, lenders who charge interest could lose the money they have lent.

Zero is the only non-arbitrary number, making it more difficult to change the maximum interest rate. That may happen for political or other reasons. The salespeople of usury can find plenty. If it is one, why not two? Zero is a clear line. A positive interest rate, no matter how small, contributes to financial instability. All positive growth rates compound to infinity, so once we start the fire of usury, it will eventually consume us.

A maximum interest rate seems feasible if it is above the rate at which most borrowing and lending occur, thereby limiting the effects on liquidity in the fixed-income market. A maximum interest rate creates room for alternatives, such as private equity and partnership schemes. These alternatives can supplement the fixed-income market and mitigate the effects of the maximum interest rate. A maximum interest rate is beneficial overall if it mainly affects questionable segments of credit, such as subprime lending.

In the case of bonds, the maximum interest rate of zero applies at the time of issuance. Due to economic circumstances or issues with the debtor, the interest rate may rise and enter positive territory. Likewise, governments may issue long-term bonds that may have positive yields if interest rates rise later on. That is not a serious issue, as long as the interest rate was zero or lower at the time of issuance.

A more serious issue is the risk of liquidity problems. When interest rates rise, less credit becomes available at interest rates of zero or lower. Interest rates might increase due to a strong economy with inflationary pressures. There are always economic agents that must borrow at all costs to meet their present obligations, so if they can’t borrow, they might go bankrupt. Businesses and individuals need to deleverage and arrange credit in advance, such as an overdraft facility, with their banks.

Another equally serious question is the profitability of banks with Natural Money. The lending business of banks will likely shrink significantly. The assumption is that risk-free lending will be profitable. But what if it isn’t? In that case, banks may need to lower the interest rates on deposit accounts to a level below the interest rate on short-term government debt. In that case, the cash interest rate may need to be lower than the interest rate on short-term government debt to make it work.

Inherent stability

Ending usury is impossible without investors having trust in the political economy or the political and economic institutions of the polity issuing the currency. The most trusted political economies have the lowest interest rates because their governments are fiscally responsible. Natural Money requires taking it to the next level. With Natural Money, to borrow, the government must find lenders willing to lend in the currency at negative interest rates. The government will be better off borrowing at negative interest rates, which provides an incentive for budgetary discipline. That is the foundation of stability.

Extracting a fixed income from a variable income stream contributes to financial instability. Fixed interest payments can bankrupt a corporation even when it is profitable overall. Interest contributes to moral hazard, as it serves as a reward for taking risks. Investors expect to earn higher yields on riskier debt, so lenders take on these risks. The more uncertain an income source, the higher the interest rate needs to be to compensate for the risk of lending, but the higher the fixed interest rate, the more likely failure becomes, which reveals the destructive consequence of interest being a reward for taking risks.

All parts of the financial system are intertwined. Individual banks can transfer these risks to the system. And so, the risk management of individual agents can increase the overall level of risk in the system. The payment and lending system is a key public interest, so governments and central banks back it. Banks take risks and reap rewards in the form of interest, while public guarantees back up the financial system. The arrangement leads to moral hazard, a mispricing of risk and private profits at the expense of the public. A maximum interest rate can end these problems.

A maximum interest rate causes a deleveraging and a reduction in problematic debts, which has a stabilising effect on the financial system and the economy. Individuals and businesses must already take action before their debts become problematic. Maximum interest rates can distort financial markets. Most notably, there will be fewer options for smaller firms to borrow. Partnership schemes should fill that void.

Interest payments also affect business cycles. The mainstream view is that central banks should raise interest rates during economic booms to curb investment and spending, thereby preventing the economy from overheating. A rosy view of the future prevails during a boom, so higher interest rates seem justified and borrowing continues for some time. When the bust sets in, the picture alters, and an overhang of debt at high interest rates worsens the woes. It would have been better if these debts hadn’t existed in the first place.

That makes a usury-based financial system inherently unstable. Natural Money changes this dynamic. When the economy improves, higher interest rates increase the attractiveness of equity investments relative to debt. That reduces the funds available for lending. The curtailment of credit will prevent the economy from overheating and avoid a debt overhang. When the economy slows, negative interest rates provide stimulus. In the absence of a debt overhang, the economy is likely to recover soon. A Natural Money financial system is inherently stable.

Featured image: 1919 Cover of The Natural Economic Order. Wikimedia Commons.

1. Simon Smith Kuznets, Stephanie Lo, Eric Glen Weyl (2009). The Doctrine of Usury in the Middle Ages. Simon Smith Kuznets, transcribed by Stephanie Lo. An appendix to Simon Kuznets: Cautious Empiricist of the Eastern European Jewish Diaspora.
2. Sekreter, Ahmet (2011). Sharing of Risks in Islamic Finance. IBSU Scientific Journal, 5(2): 13-20.
3. K. Samuelsson (1955). International Payments and Credit Movements by the Swedish Merchant Houses, 1730-1815. Scandinavian Economic History Review.
4. R. Alton Gilbert (1986). Requiem for Regulation Q: What It Did and Why It Passed Away. Federal Reserve Bank of St. Louis.

Wörgl bank note with stamps. Public Domain.

Complementary Currencies

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The collapse of complex societies

In today’s globalised economy, imports and exports account for 40-60% of most nations’ GDP, so nearly every country has integrated into the world economy. That may change if the world economy collapses. A possible cause is a sudden loss of confidence in the US dollar, which is the world’s reserve and trade currency. A collapse of the world economy may trigger a reduction in complexity, commonly referred to as the collapse of world civilisation. Such a scenario is plausible, so it is prudent to plan for it. Perhaps, we can rebuild our civilisation with local initiatives. Usually, a collapse is involuntary. Things fall apart, not because we want to, but because we can’t afford our lifestyles anymore.

In ‘The Collapse of Complex Societies,’ Joseph Tainter argues that collapse is a sudden loss of complexity because the cost of complexity outstrips its benefits, leaving us better off with simpler lives. If you can’t afford food, life can be better without mortgages, taxes, medical bills, tuition costs, and most other things you buy if it means that you have something to eat. It is not that housing, government, education, and businesses have no use. After all, complexity solves problems. Still, we could do with less, accept life as it is, and lead agreeable lives without social media and new treatments for cancer. It may seem disagreeable, but the Amish are content with that lifestyle. And we may have to.

In such situations, communities and families take on a greater role at the expense of markets and states. Village life in the past wasn’t ideal. Abusive parents could do as they pleased and get away with it. The state didn’t interfere. And if you were gay, you had better not tell. Today, the idea of community has changed. You can set up a community with like-minded people. And there has been some progress in the degree of diversity people accept, so you may not have to. Collapse means that states and markets retreat, even though the degree to which they will is unknown at present. Ideally, self-sufficiency and widely agreed-on moral values will fill in the void, but we will not return to the dark ages.

Perhaps we can learn to live in harmony with one another and with nature. That is unlikely to happen, unless a new world religion emerges. Another requirement is breaking free from the stranglehold of usury and trade. Local money enabled Wörgl to achieve some economic independence by keeping money circulating within the local economy and encouraging townspeople to buy local products. When you use regular money, such as the euro, you can buy on international markets. The money will leave the local economy and may end up on the other side of the world. You don’t know what your money will do there. It might facilitate drug trades or child labour.

Breaking free from markets

Today, there are thousands of local and regional vouchers, but few were as successful as the Wörgl scrip. One notable exception was the Red Global de Clubes de Trueque (Global Network of Barter Clubs) during the Argentine Great Depression of 1998-2002. It was an even more spectacular success. The network emerged from local initiatives following the collapse of the Argentine banking system, enabling millions to exchange goods and services using local vouchers called créditos. Argentinians lacked a reliable medium of exchange, so barter clubs, which had initially been a lifeline for the unemployed, eventually helped a significant portion of the middle class, many businesses, and some factories.

You can see the role of usury and international trade and finance in these crises. In Wörgl, a holding fee on money brought the local economy back to life, indicating that the global economy required negative interest rates, which were impossible in a usury-based financial system. To maintain a stable currency for their payments, the Argentinians could have borrowed US dollars in global markets. Due to Argentina’s creditworthiness, it could only do so at a high interest rate, which would have further eroded the country’s finances. The Argentinians would have used these US dollars to purchase foreign goods on international markets, leaving the Argentinians soon without a means of payment again.

Had Argentina been a closed economy that had only bartered with the outside world, the crisis wouldn’t have happened. That is only hard to carry out. Traders would undermine the scheme by smuggling marketable goods in and out of the country. Only a few totalitarian regimes, like Nazi Germany, succeeded in doing this. Still, the thought experiment of a closed economy explains why barter clubs were successful. And it partly explains the economic miracle of Nazi Germany. The Argentinians participating in the barter clubs had nothing to offer to international markets. Or, they supported the clubs to help their communities and were willing to forego better deals available in global markets.

Limitations

Amid a worsening depression, the Wörgl economy improved, and unemployment dropped. Wörgl achieved this by breaking free from usury and the market. The Argentinian network of barter clubs also did. And there lies a significant issue. Modern economies utilise goods and services that require a scale that only larger markets or global initiatives can provide. One of them is finance. It is probably impossible to develop local financial markets for scrip, let alone make them usury-free. The options for spreading risks in small markets are limited. The day you can go to the bank to get a mortgage in local scrip may never come.

The initiatives were successful because of an emergency. There was a lack of a reliable medium of exchange. The Argentinian barter vouchers weren’t legal tender and had no backing of a national currency. Millions of people joined the network, but it declined after 2001. The network had no organised structure. There were thousands of barter clubs in the network, each with its own notes. The clubs accepted each other’s vouchers, so some clubs committed fraud by printing additional vouchers. The Argentinian economy recovered in 2002, so the need for the barter clubs also diminished.

Whether the local or regional money is a currency or a voucher depends on the setup. An exchangeable government currency inspires trust. Most initiatives issue vouchers, but some have a currency reserve backing them. Most are private, and the money is hardly ever legal tender. Typically, these initiatives have a specific goal, such as strengthening the local community or economy. The money issued by the Austrian town of Wörgl was as close to a currency as local money can get. A government issued it, accepted it for tax payments, and guaranteed the exchange rate with the regular currency.

The Wörgl scrip and the Argentinian barter clubs demonstrate that local currencies and vouchers can succeed in times of crisis when the circular money flows have collapsed, either due to deflation (leading people to hoard money) or inflation (making the country’s currency worthless). It is also possible to integrate these local economies into a larger economy through these monetary exchanges. However, when the economy is doing well and the circular flows are functioning, the role of these monies becomes marginal. And so, they complement the regular financial system and are complementary currencies.

If you can receive internationally accepted currency, such as euros, you prefer them to barter vouchers because they inspire more trust. In times of crisis, you may be willing to take less trustworthy money if that is the only one available. It will be impossible to have a global network of local vouchers. Money operates in a hierarchy of trust. Exchangeability in a regular currency makes them more trustworthy. Imagine that there are 1,000,000 barter clubs issuing vouchers worldwide. How can you know that a note is genuine, and, if so, that the club issuing it is not scamming the system? And so, a voucher or currency can best only circulate in the area where everyone knows it.

Credit means trust, and as a Dutch proverb says, trust comes on foot and leaves on horseback. It is hard to build, but easy to lose. There are always individuals trying to scam the system. The human desire to live off the work of others is eternal. It is the foundation of capitalism, as it is what investors seek to do. And people try to use the government for their gain by demanding benefits, favourable regulations, or lower taxes. It is also a reason why trade and usury exist, not the only one, of course, but it is good to keep this in mind. The Greek god of the merchants was also the god of the thieves. It is a cynical view, as most people are honest, but systems of trust are often as strong as their weakest link.

A local economy typically offers fewer choices and often poorer-quality products than international markets. You may accept these drawbacks to support your local community, since the best deal in the market may not be the best deal for your village or country. Walmart might be cheaper and offer a wider variety of choices, but buying at Walmart comes at the expense of local stores, factories, and suppliers, so that if you buy at Walmart, your sister or neighbour ends up unemployed and must move to the city to find a telesales job in the bullshit economy.

Making it work

Imagine that everyone does something helpful rather than wasting energy and resources in the bullshit economy, that no one is on the dole, and that people with limited abilities contribute what they can. Imagine that we respect nature and that the economy is sustainable. That might be possible when we end the dictatorship of usury and markets. In that case, we may work only twenty hours per week, have enough to live on, and can do as we please for the remainder of our time. Okay, we can’t visit Disney World or watch Formula 1 car racing, which are senseless, wasteful activities, so we must entertain ourselves with other things, like playing soccer or singing in a choir.

Since 1934, Switzerland has had a business-to-business barter cooperative, WIR, which issues credit, the WIR franc backed by assets the members have pledged in collateral. Businesses trade goods and services without using cash, allowing them to work with less financial capital, clear excess inventory, and build new business relationships. The United States has several barter organisations with varying credibility. Most are for-profit, so serving a community is not their primary objective.

Another scheme that can strengthen the local community is the Farmer-Citizens Initiative, also known as the Pergola Association. The market for agricultural produce is competitive, subjecting farmers to international finance and global markets. Farmer-citizens’ initiatives have varying setups. Usually, citizens pay a subscription fee to cover the farm’s expenses in exchange for a share of the produce. It enables farms to diversify and offer a broader range of food products. Rather than exploiting immigrants, farmers may hire locals to do chores. That is possible because these farmers don’t produce for global markets. The transactions can be in local scrip.

Government support can help. The Wörgl municipality accepted its currency for tax payments. Complementary currencies are not a recent invention. Accepting a currency as payment for taxes, or even requiring payment in that currency, has been a way for governments to generate demand for it, allowing them to issue currency without backing it in precious metals. In England, tally-stick money circulated within the country, as it had value only there, allowing local state money to coexist alongside the merchant’s money, gold coin, insulating the nation’s economy from the whims of international trade.

In a Natural Money financial system, local governments, such as municipalities, can issue local and regional currencies backed by national currencies or the global reserve currency (GRC), which are debts of national governments or the world government in the International Currency Unit (ICU). In a more decentralised world with a uniform law system, nation-states aren’t the highest authority. They, however, issue debts in the ICU, so there can be national currencies based on these debts. Municipalities can issue debts in the ICU. Using them as backing for local currencies makes maintaining parity with the national currency a challenge. And so, a full backing is of the essence.

To end usury and have lending, you not only need trust, but also efficient financial markets. Interest rates below zero can only exist when lenders expect repayment and the currency to have a stable value. In a small community, there are few lenders and borrowers, resulting in limited options. Raising capital for a new business or a mortgage in a local currency is probably impossible. And if a single business fails, a small bank can get into trouble. In larger financial markets, banks can diversify their investments.

Local monies are complementary, supplementing the regular financial system rather than replacing it. Preferably, their value stays on par with the regular currency. Only a full backing like in Wörgl can guarantee that. Small-scale lending and borrowing in these currencies based on personal trust is possible. It is not feasible to develop financial markets in them. Still, in a future where communities become increasingly self-sufficient, complementary currencies will play a more significant role than they do today.

To make it work, we should have motives beyond securing the best deal or maximising profit. So far, these other motives haven’t moved mountains. That is because only faith can. Money gives us a false sense of security. It promises us that we can buy anything we want, at any time we want. But money is not a basement full of foodstuffs or safety to walk the streets. Once we have ruined this planet and society falls apart, we will find out. Still, we put our faith in money. If it is not the euro, we put our faith in gold and silver rather than our communities. That is because trade and usury have destroyed them.

Latest revision: 12 November 2025

Featured image: Wörgl bank note with stamps. Public Domain.

Deutsche Bank Towers in Frankfurt am Main

What Is the Use of banks?

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Turning debt into money

The previous episode about money discussed some imaginary trades between you, a hatter, a lawyer, a barber and a fisherman. It is shown that if people promise to pay this might suffice for payment. So if the fisherman promises you to pay next week for the hat you just made, you could say to the lawyer that you expect the fisherman to pay in a week, and ask her if you can pay in a week too. The lawyer could then ask the same of the barber and the barber could ask the same of the fisherman. If all these debts cancel out then no cash is needed.

In most cases, debts cannot be cancelled out so easily. A hat may cost € 50, legal advice € 60, a hairdo € 30, and the fish € 20. If you are the hatter, you could lend € 10 to the barber and the lawyer could lend € 20 to the fisherman. Perhaps the lawyer doesn’t trust the fisherman because he smells fishy. But if the lawyer trusts the barber and the barber trusts the fisherman then the lawyer could lend € 20 to the barber and the barber could lend € 20 to the fisherman.

That could become complicated quite easily. And this is where banks come in. Banks can lend money because they know the financial situation of their customers. The fisherman can borrow money from his bank to make payments because the bank knows that he has an unstable but good income and a vessel that can be sold for cash if needed.

If the fisherman borrows money to pay for the hat you made, this money ends up in your account. You can use it to pay the lawyer. And so the fisherman’s debt becomes the lawyer’s money until she uses it to pay the barber. People that have a deposit lend money to the bank and the bank is lending this money to those who have a loan, in this case, the fisherman. Depositors trust the bank even though they do not know the people the bank is lending money to.

Most people think of money as coins and banknotes but more than 90% of the money just exists as bookkeeping entries in banks. When a fisherman borrows money from his bank, he can spend it on a hat. This means that the bank creates money and that this money is debt. Most of our money is debt so the value of money depends on the belief that debtors pay back their debts. This seems scary and it keeps quite a few people awake at night.

Some people argue that debts and banking are frauds because they are based on a belief. But banks and debts help to boost trade and production by creating money that doesn’t exist to start businesses that don’t yet exist to make products which will be bought by the people those businesses will hire with this newly created money. Banking and debts are the basis of the capitalist economy.

Banking as bookkeeping

Banking is more or less just bookkeeping and balance sheets. Balance sheets can be used to explain the magic trick banks do, which is creating money. Balance sheets are simple. There are no intimidating formulas, only additions and subtractions. The important thing to remember with balance sheets is that the total of the amounts on the left side must always equal those on the right side.

On the left is the value of your stuff and your money. On the right side is the value of your debts. Your net worth is what remains when you sell all your stuff and pay off your debts. It is on the right side too in order to make it equal to the left side. Your net worth can be a negative value. If that is the case, you might be bankrupt because you can’t repay your debts by selling your assets. The left side is named debit and the right side is called credit. Your balance sheet might look like this:

debit
 
credit
 
house
€ 100,000
mortgage
€ 80,000
other stuff
€ 50,000
other loans
€ 30,000
cash, bank deposits
€ 20,000
your net worth
€ 60,000
total
€ 170,000
total
€ 170,000

When you buy a car, you own more stuff, but also another loan or fewer bank deposits as you have to pay for the car. This is because debit always equals credit. When you drive the car, it goes down in value, as does your net worth, because debit always equals credit. If your salary comes in, your bank deposits as well as your net worth rise because debit always equals credit. If you pay down a loan, the amount in your bank account, as well as the amount of your loan, goes down because debit always equals credit. If debit doesn’t equal credit then you have made a calculation error.

Also for a bank, the total of the amounts on the left side must always equal those on the right side, so that debit always equals credit. Your debt is on the debit side of the bank’s balance sheet. You have borrowed this money from your bank. The bank owns this loan. Your bank deposits are on the credit side of the bank’s balance sheet. The loans of the bank are paid for by deposits. Banks lend money to each other. This may happen when you make a payment to someone who has a bank account at another bank. Your bank may borrow this money from the other bank until another payment comes the other way. The balance sheet of a bank may look like this:

debit
 
credit
 
mortgages and loans
€ 70,000,000
deposits
€ 60,000,000
loans to other banks
€ 10,000,000
deposits from other banks
€ 20,000,000
cash, central bank deposits
€ 10,000,000
the bank’s net worth
€ 10,000,000
total
€ 90,000,000
total
€ 90,000,000

How banks create money

Banks create money. How do they do that? It is easy if you understand balance sheets. Assume that you, the hatter, the lawyer, the barber, and the fisherman all have € 10 in cash. Together you decide to start a bank. You all bring in the € 10 you own so that you all have a deposit of € 10 and the bank has € 40 in cash. The bank allows everyone to withdraw deposits in cash. This is no problem as long as the total of deposits equals the total amount of cash. After everyone has put in the deposit, the bank’s balance sheet looks as follows:

debit
 
credit
 
cash
€ 40
your deposit
€ 10
  
deposit lawyer
€ 10
  
deposit barber
€ 10
  
deposit fisherman
€ 10
total
€ 40
total
€ 40

First, there was only € 40 in cash. Now there are € 40 in bank deposits too. You might think that the bank created money. Only, that isn’t true because the depositors can’t spend the cash unless they take out their deposits. In other words, the depositors don’t have more money at their disposal than before. If you look at the total, there is still € 40. This is bookkeeping. You have to write down the total twice as debit must equal credit.

But now things are going to get a bit wild. The fisherman comes to you and he wants to buy a hat. The hat costs € 50 but the fisherman has only € 10 in his account. To make the sale possible, the bank is going to do its magic. The fisherman calls the bank and asks if he can borrow some money. The bank grants him a loan of € 40 and puts the money in his deposit account so that he can spend it. And look:

debit
 
credit
 
cash
€ 40
your deposit
€ 10
loan fisherman
€ 40
deposit lawyer
€ 10
  
deposit barber
€ 10
  
deposit fisherman
€ 50
total
€ 80
total
€ 80

Who says that miracles can’t happen? The deposits miraculously increased from € 40 to € 80 so € 40 is created from thin air. There is still only € 40 in cash but the fisherman’s debt created new money. This is how banks create money. And that is only because bank deposits are money. This is all there is to it. So much for the mystery. The fisherman then pays € 50 for the hat. And so it becomes your money:

debit
 
credit
 
cash
€ 40
your deposit
€ 60
loan fisherman
€ 40
deposit lawyer
€ 10
  
deposit barber
€ 10
  
deposit fisherman
€ 0
total
€ 80
total
€ 80

And now comes the dreadful part that keeps some people fretting. Everyone can take out his or her deposits in cash. There are € 80 in deposits and only € 40 in cash. If you go to the bank and demand your € 60 in cash, the bank would go bankrupt, even when the fisherman pays off his loan the next day. You could bankrupt the bank by buying € 50 in fish with cash. If you go to the bank to get € 50 in cash it would not be there so the bank would go bankrupt before the fisherman can pay off his loan with the same cash.

A bank could get into trouble in this way even when debtors repay their debts. Clever minds already figured out a solution. Central banks can print money too. If the European Central Bank (ECB) prints € 20 on a piece of paper and lends this money to the bank, there would be enough cash to pay out your deposit. Banning the use of cash and only using bank deposits for payments would be another option. So, after the ECB deposited € 20 in cash, the bank’s balance sheet might look like this:

debit
 
credit
 
cash
€ 60
your deposit
€ 60
loan fisherman
€ 40
deposit lawyer
€ 10
  
deposit barber
€ 10
  
deposit fisherman
€ 0
  
deposit ECB
€ 20
total
€ 100
total
€ 100

After you pay the fisherman, he can pay off his loan, and the bank will have enough cash to pay out all deposits. The bank can repay the central bank and everything is fine and dandy again. In this case the bank could not meet the demand for cash but the value of cash and loans wasn’t smaller than the deposits (the bank’s debt). After the fisherman pays back his loan and the bank pays back the ECB, the bank’s balance sheet might look like this:

debit
 
credit
 
cash
€ 40
your deposit
€ 10
loan fisherman
€ 0
deposit lawyer
€ 10
  
deposit barber
€ 10
  
deposit fisherman
€ 10
  
deposit ECB
€ 0
total
€ 40
total
€ 40

If banks can’t create money, trade would be difficult. If the hat is € 50, the legal advice € 60, the hairdo € 30, and the fish € 20, and you, the lawyer, the barber and the fisherman all have only € 10, nothing can be bought or sold. If the bank lends € 40 to the fisherman, he can buy a hat from you, you can buy legal advice from the lawyer, the lawyer can buy a hairdo and the barber can buy fish. Debt is the basis of the capitalist economy. Nearly all money is debt, and without debt, the economy would come to a standstill.

How much money can banks create?

The amount of money a bank can create is limited by the bank’s capital, which is the bank’s net worth. Regulations stipulate that banks should have a minimum amount of capital. This is the capital requirement. If the capital requirement is 10%, and the bank’s capital is € 10,000,000, it can lend € 100,000,000, provided that there are enough deposits. If the bank makes a loan, a new deposit is created. If the deposit leaves the bank, the bank must borrow it back from another bank or cut back its lending. That is because debit must always equal credit.

debit
 
credit
 
mortgages and loans
€ 70,000,000
deposits
€ 60,000,000
loans to other banks
€ 10,000,000
deposits from other banks
€ 20,000,000
cash, central bank deposits
€ 10,000,000
the bank’s net worth
€ 10,000,000
total
€ 90,000,000
total
€ 90,000,000

When a deposit leaves the bank, it ends up at another bank. The other bank can use it for lending, provided that it has sufficient capital. There may be a reserve requirement, which is a minimum of cash and central bank deposits the bank must hold. If the reserve requirement is 10%, the bank can lend out as much as ten times the amount of cash and central bank reserves it has available. In the past, reserve requirements were important as people often used cash and could go to the bank to demand their deposits in cash. For that reason banks needed to hold a certain amount of cash.

Featured image: Deutsche Bank building CC BY-SA 4.0. Raimond Spekking. Wikimedia Commons. Public Domain.

Wörgl bank note with stamps. Public Domain.

Cash for Negative Interest Rates

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The problem with cash

Dealing with cash is cumbersome for both businesses and banks, so they are increasingly opting for digital payments. It helps to reduce their costs. Increasingly, people are opting for digital payments over cash. Geezers might still prefer to pay with banknotes and coins, but youngsters often don’t. These are the primary reasons why banknotes and coins could soon go extinct. The authorities have also sought to reduce the use of cash because it has long been the preferred method of payment for criminals.

Cash still plays a significant role. In the European Union, people mainly use them for small transactions. Cash can become an attractive investment when interest rates are negative. In Switzerland, where interest rates have been the most negative at -0.75%, 1,000 franc banknotes and safe deposit boxes were in short supply. And so, interest rates below -1% seem impossible as long as cash yields zero.

When depositors take their money from the bank, the bank can run into trouble. That may happen when interest rates fall below zero. A holding fee on central bank money, including cash, of 12% per year, can make it attractive to lend money at negative interest rates, like -2%, as you don’t pay the holding fee on loaned funds. Bank deposits are money lent to banks, thus loaned funds. You may keep your money in the bank when interest rates are negative because cash has a lower interest rate.

Cash as a loan to the government

In Wörgl, the townspeople bought stamps and glued them to the banknotes to keep them valid. It would be more practical if we didn’t have to glue stamps on banknotes. And a holding fee of 12% per year would make cash unattractive. The charge doesn’t need to be that low to prevent people from withdrawing their money from the bank and putting it in a safe deposit box. If the interest rate on cash were a bit lower than the interest rates on bank accounts, that would be enough to stop people from hoarding banknotes.

When cash is a loan to the government, the interest rate on cash could be the same as the interest rate on short-term loans to the government. That rate would be better than the holding fee and could be as low as -3%. There can be an exchange rate between cash and central bank money. The value of cash would gradually decrease at a rate of 3% per year, and you don’t have to glue stamps on banknotes to keep them valid. The situation resembles 3% inflation, but it is a negative interest rate.

That difference is crucial because negative interest rate currencies may not require government or central bank management. They provide financial stability themselves. There is no money shortage due to interest charges, so there is no permanent need to expand debts to sustain the usury scheme, which requires government and central bank management. With negative interest rates, the money supply can be stable or even shrink without adverse consequences for the financial system or the economy.

Human psychology

Negative interest rates visibly reduce the currency balance in your account, while inflation operates more stealthily, by robbing you while you believe you get more. Wage changes are more noticeable than price changes, as some prices decrease while others increase in value. Even when negative interest rates and deflation are a better deal, and even if we all know it, we might not opt for them. The phenomenon is known as the money illusion. We resist a reduction in monetary units, even if it would make us better off.

It also affects how we look at negative interest rates. When interest rates are negative, money disappears, so inflation is likely to be lower, and prices may even decrease. That could be a better deal for depositors if their real return were higher, but most people dislike seeing their account balance decrease due to a negative interest rate. They might get edgy about their money vanishing into thin air. Negative interest rates sparked outrage among some Belgian depositors, who demanded a ban on these rates.

We prefer the illusion of a small gain that amounts to a loss in reality to the illusion of a similar loss that is, in fact, a better deal. It is not rational, but human psychology is the way it is. We are emotional beings that can think rather than thinking creatures with emotions. There is a fix: hiding negative interest rates and making them appear as inflation. To explain how we can look at the characteristics of Natural Money:

  • The administrative currency carries a holding fee of approximately 12% per year. If you own this money, €1.00 turns into €0.88 after a year. It can make lending at negative interest rates attractive.
  • Interest rates on bank accounts might be around -2% per year. Depositors don’t pay the holding fee, but the interest rate the bank offers.
  • Cash is a short-term loan to the government and carries the interest rate of short-term government loans, which might be -3%.
  • The administrative currency and cash become separate currencies. Cash gradually loses value relative to the administrative currency.

Making cash the money in people’s minds

When bank account statements are in cash currency rather than administrative currency, the public doesn’t notice that the interest rate is below zero. The interest rate on short-term government loans is one of the lowest. Banks must be able to offer at least this interest rate so that people won’t see their balance shrink due to negative interest. And if shops express their prices in the cash currency, it will become the currency in people’s minds.

If the interest rate on cash is -3%, its value decreases by 3% per year in terms of the administrative currency. If a bank offers an interest rate of -2% and settles the account in cash, the interest on the bank account appears to be +1%. And if the deflation rate is 1%, prices go down by 1%. Meanwhile, the value of cash decreases by 3% in the administrative currency, so prices in the cash currency increase by 2%. And so, the public experiences 2% inflation.

You can see it as a deception to prevent people from deceiving themselves. People get aggravated by negative interest rates, but largely ignore inflation. They also fall for the illusion of getting more when interest rates are positive. When the interest rate on bank accounts is 1% and inflation is 3%, you would lose 2% in purchasing power per year by holding a balance in a bank account. A 1% loss is a better deal for depositors. Natural Money can improve the economy, allowing real interest rates to be higher.

Critics might argue that we could be fooled by this scheme, just like inflation fooled us before. We won’t notice the negative interest rate, just like we did inflation before. Separating cash from the administrative currency and expressing prices and the value of bank accounts in cash currency can clear the psychological barrier that stands in the way of the public adopting negative interest rates.

The administrative currency remains the accounting unit in the financial system for bank accounts, debt, and interest, as well as the prices of financial assets, such as stocks and bonds. A similar situation existed in Europe between 1999 and 2002. After introducing the digital euro, cash continued to be the national currency. With Natural Money, the maximum interest rate of zero applies to the administrative currency and not to the cash currency, so interest rates in the cash currency may be above zero.

Latest revision: 1 November 2025

Featured image: Wörgl bank note with stamps. Public Domain.